Caught in the riptide of multiple headwinds – the lingering impact of Covid 19 in parts of the globe causing intense disruptions on the supply side, with the armed conflict between Russia and Ukraine pushing up global prices oil to a new unsustainable high, central banks around the world on frenzied policy rates, shrinking liquidity and shifting policies to wage war against the inflationary beast echo the challenges of policymakers.
The domestic macroeconomic trajectory is no different from the rest of the world, with inflation crossing the upper bound of RBI comfort levels and the recent rise in energy prices expected to fuel inflation that could potentially disrupt the recovery economy due to rising input costs. RBI is cautious but proactive in mitigating the negative impact on India’s growth, inflation and financial conditions.
RBI is known for its unconventional, innovative and offbeat approach in changing the tone and tools of monetary policy to align with crisis situations. First the catastrophic pandemic risk that has been sweeping the economy over the past two years and now the impact of a hostile geopolitical storm hitting many parts of the globe, adding to uncertainties and risks.
In view of these historic adversities, the RBI’s Monetary Policy Committee unanimously kept key rates intact – repo rate at 4% and reverse repo rate at 3.35%. The Marginal Standing Facility (MSF) rate and the discount rate remain unchanged at 4.25%.
Not aligning with its global peers and limiting the rise in key rates requires a great deal of perseverance and the ability to take the risk of tolerating the onslaught of inflation in the short term. This is precisely why, although he has maintained an accommodative policy for the time being, but with a subtle shift in stance on inflation. monetary policy “must remain accommodative while focusing on withdrawing accommodative measures to ensure inflation remains on target going forward, while supporting growth.” So far, in the past two years, ‘the monetary policy stance has remained accommodative for as long as necessary to revive and sustainably support growth and continue to mitigate the impact of COVID-19 on the economy.” The change is transparent and appropriate. If inflation rises above the RBI’s comfort level, the policy stance could be changed. This adds a touch of leeway to the RBI to change its position according to the path of inflation. The central bank’s proactive shared-minded policy provides a high degree of transparency. Market participants must be able to understand when change may occur and can avoid knee-jerk reactions and maintain stability in building market sentiment. Despite a possible rise in inflation, RBI is confident that rising interest rates can still wait while liquidity-absorbing tools act to neutralize excess liquidity.
- Nuances of cash management:
The non-disruptive neutralization of extraordinary cash transported to meet pandemic-related needs is essential. According to RBI, almost Rs 17.2 trillion had to be injected under various relief measures through TLTRO/LTRO, of which Rs 11.9 trillion was utilized, Rs 5 trillion was returned to due dates. There is still a cash surplus of Rs 8.5 trillion in the system.
The central bank had already started to normalize its liquidity flow in the previous fiscal year by absorbing excess liquidity through variable rate repo auctions (VRRR) and was also ensuring liquidity availability through variable rate repos (VRR), as needed to ensure transparent liquidity management. . It had absorbed 80% of the excess liquidity under the LAF in the fourth quarter of 2021-22 at an interest rate close to the policy rate via the VRRR.
In addition to these two tools, RBI has taken a concrete step by restoring the policy rate corridor under the Liquidity Adjustment Facility (LAF) to a pre-pandemic width of 50 basis points by introducing a permanent deposit (SDF) at 3.75% as the floor of this corridor. The amendment to Section 17 of the RBI Act in 2018 allowed RBI to introduce the SDF. By removing the binding guarantee constraint on the central bank, the SDF strengthens the framework for the operation of monetary policy. This was imminent given the sharp rise in inflationary pressures.
Market participants had more or less prepared for a move like this, as the RBI had held VRRR auctions to suck up excess liquidity at rates that firmed closer to the political repo rate.
The SDF facility will be a tool to absorb excess liquidity from the system and will be applicable to demand deposits at this stage. The SDF will have the capacity to absorb longer-term liquidity should the need arise.
At both ends of the liquidity corridor, the standing facility at the base will absorb liquidity while the one at the other end will inject liquidity. In addition, access to SDF and MSF will be at the discretion of the banks. RBI has therefore devised its way of gradually neutralizing and merging excess liquidity with the main liquidity of the system.
As the covid-related adversities of the past two years persist, the war has added new dimensions to potentially hamper economic recovery due to rising commodity prices and global spillover from supply-side disruptions. The influence of monetary policy normalization in advanced economies, the resurgence of COVID-19 infections in some large countries with heightened supply-side disruptions and prolonged shortages of critical inputs may potentially pose risks downside for the economic outlook.
Given these looming challenges, RBI has downgraded its outlook by 60 basis points and expects real GDP growth for 2022-23 to reach 7.2% from 7.8% previously estimated. This will depend on whether crude oil prices remain close to US$100 during the year. Similarly, the outlook for inflation has been raised sharply to average 5.7% in FY23 from a previous estimate of 4.5%. But much will depend on how the current war unfolds and how energy prices play out in times to come.
With the clarity provided to market participants as to how the future course of the policy is about to be unveiled, they should be able to use the low-cost extended window to stimulate investment and expand the market. capacity utilization (CU). Of note, UC improved to 72.4% in manufacturing in Q3 FY22 from 68.3% in the previous quarter, surpassing the pre-pandemic level of 69.9% .
It is here that well-placed banks should take over the financing of potential growth with RBI poised to maintain adequate liquidity. With deposit rates and growth looming with possible capital inflows, inclusive action by banks will go a long way in boosting growth. The regulatory measures go in the direction of real estate credit, digitalization and consumer protection. With the Emergency Credit Line Guarantee Scheme (ECLGS) limit raised to Rs. 5 trillion to assist the MSME sector, acceleration of credit flow is needed to weather the turmoil. With RBI and the government on its feet, inclusive participation can shape ‘Atmanirbhar Bharat’ to set global standards to weather the geopolitical storm.
The opinions expressed above are those of the author.
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